Some insurance companies have introduced life insurance contracts that are like variable annuity contracts with respect to the investment of the cash values in the contract. Many commentators have been negative about these contracts because of the higher costs and lower returns on the amount invested.

However, most of the critics don’t seem to place any value on the life insurance element of the contract. If you don’t need any life insurance, a variable annuity contract will be more profitable. But if you are buying life insurance and you are investing in a variable annuity, you might find that the variable life insurance contract is a better deal. because it provides the benefits of each and eliminates some of the disadvantages of the variable annuity. 

What is rarely mentioned is that the cost of the life insurance in a high cash value life insurance contract is essentially being paid for with tax free dollars. And, in a variable life insurance contract, the internal cost of the life insurance is usually less than a comparable amount of term insurance. If you select a policy that has a low commission (referred to as a “low-load” policy), your returns will be significantly better. The trouble is, your friendly local insurance agent isn’t going to call on you to tell you about these contracts, You have to go looking for them. 

As an illustration of the tax free life insurance premium that’s included in a cash value insurance policy, let’s assume that a single year’s premium on a $100,000 term insurance policy would be about $200 for a male at the age of 45. Then let’s assume that you buy a $100,000 variable life policy with a $10,000 initial premium. The company may credit your contract with 5% of the cash deposit, providing you with $500 of tax deferred income. Then, the company deducts the cost of the insurance premium - which might be $150 instead of $200. You end up with a return of $350 on your $10,000 cash value, which doesn’t look very good compared to a variable annuity contract. But part of your return has paid for the premium on a life insurance contract. If you die, your heirs will get $100,000 free of income taxes instead of $10,350. With the annuity contract, they might get $10,600 but it will be subject to income taxes in the estate of the policy owner. 

And .... when you die, the benefits are included in your estate, but if you  leave most of your estate to a surviving spouse, there is no estate tax until your spouse dies.  Through the use of an irrevocable life insurance trust, it would be possible to arrange to have the life insurance policy owned by the trust and the death benefit would not be subject to estate taxes. 

Another advantage of the life insurance contract over the variable annuity is that you may be able to borrow against the contract without any penalty and without having to pay taxes on the loans. In fact, with some policies, you could withdraw the cash value tax free as loans without anyone ever having to pay income taxes on the distributions. You do have to pay some interest to the insurance company for your loan, but the interest you pay is just added back to your cash value and can be borrowed out at a future date. However, in order to be able to take out non-taxable policy loans, your policy must require a minimum of five to seven years of premiums. A single premium policy is treated like an annuity contract for tax purposes. 

As with a variable annuity, the variable life policy cash value can be invested in a variety of different kinds of funds to obtain some diversification. Policy owners can shift the allocation of the cash value from one fund to another at least once a year and sometimes more often (depending on the insurance company). This is particularly appealing to those who feel they can profit from some "market timing" in terms of whether to have their funds in equities, cash or other fixed income investments.

Substantial asset protection is available to insurance contracts in many states, but for those who seek greater protection from the hazards of litigation, the contract can be acquired from a foreign life insurance company. So long as the insured does all of the application procedures outside the U.S., and so long as the policy is compliant with U.S. tax laws for life insurance contracts, the tax treatment of a foreign life insurance policy is basically the same as for a domestic policy. An extensive discussion of foreign life insurance contracts is included in the Offshore Tax Seminar Manual which I co-authored with Richard Duke.


Vern Jacobs
 

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